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China’s Sly Devaluation

For the past few decades, China’s economic miracle has been a wonder of the world. We’ve seen double digit GDP growth (even accounting for exaggeration in the CCP’s official figures) and the rise of Beijing as a major player in global trade and military power. But after a whirlwind year that saw the value of Chinese stocks more than double, the market is taking some big hits, and the prospects for future growth are dimming.

As we’ve followed closely, President Xi Jinping seems to have been battening down the hatches, looking ahead to a period of major financial instability, pretty much since he took office. Now that the storm appears to have arrived, his government is taking radical steps to stop the damage. After the first few days of the collapse, for example, Beijing froze trading on the vast majority of listed companies; in effect, true to authoritarian nature, the Party simply ordered the market not to decline.

And then yesterday, Beijing devalued the renminbi by the largest amount since it switched to its current currency regime in 1994. Calling it a “convenient reform,” Bloomberg offers some solid analysis:

By allowing markets a bigger role in valuing the yuan exchange rate, the People’s Bank of China is ticking off a box in its campaign to internationalize its currency. Central to this plan is a bid to have the yuan accepted by the International Monetary Fund into its basket of reserve currencies, known as the Special Drawing Rights or SDR. That would place the yuan on par with the dollar, euro, yen and British pound, and boost China’s global stature.

China’s central bank has typically kept a tight rein on movements in its currency, setting a daily rate for the yuan and the dollar, sometimes in defiance of market forces.

Market-makers who submit prices for the PBOC’s reference rate will now have to consider the previous day’s closing rate, demand and supply, and changes in major currencies. Previous guidelines had no mention of these criteria.

[…]

The yuan’s real effective exchange rate — a measure that’s adjusted for inflation and trade with other nations — climbed 14 percent over the last four quarters and was the highest among 32 major currencies tracked by Bank for International Settlements indexes.

“The central bank would never admit they are weakening the currency to help exporters, but clearly they’re complaining about the real effective exchange rate’s strength,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB. “It is a way to kill two birds with one stone.”

China already wanted to devalue the renminbi, which its standing policy had more or less pegged to the dollar, in order to make its exports more desirable for Europe and the developing world: more favorable exchange rates with trading partners equals more exports, and like it or not, Beijing hasn’t been able to overcome the market forces keeping it from moving past the export-driven growth model. So by timing it to coincide with the market’s troubles, Beijing gets to save face. Savvy move.

But even if this sleight of hand works, that doesn’t solve the basic, structural problem underlying the Chinese market’s recent travails, and it raises questions about how Beijing will react when everybody is eventually forced to admit that most of its self-inflicted bubbles have popped. As Einstein is said to have remarked in a very different context “the great miracle of the universe is that there are no miracles.”

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  • FriendlyGoat

    Doesn’t the first paragraph of the Bloomberg analysis explain why this move is good for China in the long run and something we should be more concerned about than criticizing or making fun of?

    • f1b0nacc1

      Bloomberg seems more interested in China’s attempt to get institutional recognition than any actual benefits for China per se. Now it does benefit China (at least in the short term), or rather its manufacturing sector to devalue its currency (makes their exports cheaper), but unless you believe that China’s future is anything other than a source of cheap manufactured goods, this won’t help.
      It is a smart short-term move as it helps the government stabilize their economy, and inflating the currency will certainly help those who are able to arbitrage a bit….i.e. government cronies, but the long term effects aren’t likely to be too positive.

      • FriendlyGoat

        For better or worse, I believe China’s long-term future is as a major player in a multi-polar (a Putin-favorite term) world. To my way of thinking, there is no way it’s influence and power does anything but grow over future decades, even if with economic ups and downs.

        They want to be a reserve currency. It’s hard to imagine why they won’t be——over some time.

        • f1b0nacc1

          This reminds me of the same confident predictions about Japan in the 80s…they were going to be a major player (in fact they were going to own us), and their power would only grow.
          Wrong then, wrong now. China has a major population problem (rapidly aging, serious gender imbalance due to their ‘one-child’ policy), their economy is dependent upon exports which are in turn built upon cheap labor and rampant corruption/cronyism which is not sustainable over the long run, and their resource shortages are growing critical. I will leave the question of whether they can remain competitive in technology to Jackson-Lib and his “magic of competition”, but there is even better reason to believe that they are unable to sustain a viable technological challenge without a robust espionage regime, and I suspect that that won’t last forever.
          The Yuan is a poor choice for a reserve currency, and this recent set of events demonstrates why. With that said, lets revisit this in 10 years and see…

        • Kevin

          I think the first paragraph is true. I’m not sure about the second – is the renminbi liquid enough to serve as a reserve currency? A currency with serious currency controls and non-market political interference via diktats is not really suitable for such a role.

          • FriendlyGoat

            Isn’t that what they have just taken a first step to start fixing?

          • Kevin

            FG – I’m not up on all the latest developments here but I think not – they are trying to avoid having a floating currency and are managing it drive exports as well as prevent volatility in the exchange rates. In order to do this, they are increasing their intervention in the currency market as signaling that they will do so in the future. As this seems to be going hand in hand with a “beggar thy neighbor” series of competitive devaluations it could set of a chain reaction throughout Asia if it continues.

            Of course this is just he first move here, but I think it points to greater Chinese government intervention in the currency markets to support their domestic economic and political objectives.

          • FriendlyGoat

            Okay. You may be right. We can all wait and see how they fare.

  • Nevis07

    An interesting take on events from A.I., but I think this is a harbinger of potentially worse things to come.

    Frankly, I think it would be best if the US gov. slowly and quietly encouraged corporations to rely less on Chinese growth. I know a slowdown there will automatically cause the market to adjust to that reality anyway, but I want the US to have a freer hand in dealing with China if things go south. The US is already more or less a closed economy and IT will constitute a bigger picture of future industry and jobs anyway. Add in the fact that robotics is quickly changing the manufacturing picture in terms of labor costs to that of transport costs and suddenly we can take back more control of our future, even if it means potential loss of a higher growth market.

    Simply said, I think there is a geopolitical angle here that needs to be considered. Authoritarian and dictatorship regimes rarely end well and often act out aggressively. I’d prefer our supply chain not be so tied up in China – and if China does liberalize and finally open it markets and rise peacefully, we’ll get those signs along the way – but until then, I’ve become increasingly pessimistic.

    • Jacksonian_Libertarian

      I think the numbers are clear, foreign investment has basically dried up for China, and the smart money has already gotten its investments out of China.

      I want to use China’s belligerence, treaty violating land grabs, and territorial ambitions to break open Asian markets to freer trade, and create a military alliance to protect trade on the high seas. I’m not that worried about China, without the foreign investors, their cutting edge factories, and their brand name captured world markets, China’s export dependent economy will crash.

      China is also extremely vulnerable to a strategic blockade, as 40% of its economy is dependent on world trade, and it has unwisely enraged all the nations which sit on its shipping routes.

      Finally, China is holding some $1.3 Trillion in US Treasuries, and an additional $2.7 Trillion in other foreign Treasuries. In the event of a war these debts will be the first thing to be renounced. Since China has been been using the purchase of US Treasuries and other foreign Treasuries to manipulate (devalue) their currency and give their exports a price advantage. They might not care too much, but watching $4 Trillion vanish overnight is going to sting coming at the same time as their ports are all shut down and their world markets get lost probably forever.

      • Nevis07

        I agree with pretty much all of what you say, but I’m still on the cautious side. Growth may well pick up again for China depending on a number of conditions and of course corporations are still trampling over each other to get the best positions in the largest market on earth. They hold very little allegiance.

        I think China’s government has been their own worst nightmare. As you’ve pointed out their aggression in the region has worked against them, but the US has only a very fragmented alliance system in Asia. There was a great piece from The Diplomat on this recently. The US, at the end of the day is clearly the only one that can hold the peace.

        Totally agree with you on the debt issue. History has shown time and again that creditor holds the upper hand after hostilities break out. That of course is not to say that the US wouldn’t take a hit in debt market interest pricing as a result. But at the end of the day, the US Dollar doesn’t have a peer – as yesterday’s events clearly show.

        The biggest problem I see is this: 1) the supply chain; true we can easily live without the latest version of the iphone, but any blockade would undoubtedly cause all sorts of logistical problems and perhaps rare earth elements is the biggest problem we’d have to deal with. A blockade works, but hurts us because of our dependence on China – hence my original comment. 2) I think that China feels they can continue to be hostile towards it’s neighbors and the US, because of our ‘mutual dependence’. In fact, I think they’ve come to rely on it to have free reign over the region’s geopolitics. I’d like to take that away from them, or at the very least give them pause. 3) corporate espionage is obviously a big element to China’s success. Now they might have gotten much better at it via the internet, but that doesn’t mean we should make it any easier for them by bringing our technology to them on a silver platter.

        • rheddles

          I agree with all the discussion above, but it doesn’t mention the greatest source of risk in China, its demographic meltdown which appears to be arriving even faster than anticipated. Peak China. See http://nationalinterest.org/feature/coming-soon-chinas-demographic-doomsday-13534

          As to the debt issue, I don’t see how suspension of payments to a belligerent state in time of war would hurt the dollar’s standing in the market. I would think we have done the same to Iran to the extent it holds any US Treasuries. In any case, war would mean the end of access to the western banking and clearing systems. That would be far more damaging for China as it is far more reliant on trade for energy than the US.

          • Nevis07

            True, their demographics is a big problem for them. How this plays out socially and otherwise will be something we’ll have to keep any eye on.

            I mis-typed above, I should have typed the “debtor” usually holds the upper hand in these situations. But what I was trying to allude to in terms of bond and treasury markets, that I think a lot of people misunderstand is that controlling China from calling in our debt is not as simple as it sounds. While banks, the Treasury and our clandestine organizations might know a good portion of the accounts where that debt is held, a large portion is likely held in accounts that’s mixed with other legitimate buyers. In other words, if China holds a couple billion in debt securities via a hedge fund, it’s not so easy to just freeze that account. You’re going to get ‘innocent’ caught up in that freeze as well. That mean’s global finance is going to be disrupted one way or the other. The US can lessen the impact, but at the end of the day money is tangled up and mixed with other funds.

  • Kevin

    The U.S. gov’t will not be pleased if the Chinese devalue much. There has been a strong U.S. push to get them to allow the currency to appreciate in order to reduce the trade deficit. This could be a major issue next year of the Presidential contest is fought over blue collar jobs and Midwestern manufacturing states.

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